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Cronies Everywhere

By Kemal Derviş
From the Middle East and Russia to China and many other countries around the world, crony capitalism is alive and well. But what does this well-worn term actually mean in practice, and can it tell us anything about the likely fate of Russian kleptocracy, Chinese "state capitalism," or Middle Eastern rentier states?
MOSCOW, RUSSIA – JULY 4: (RUSSIA OUT) Russian President Vladimir Putin (R) shakes hands with Chinese President Xi Jinping (L) during their meeting at the Grand Kremlin Palace on July 4, 2017 in Moscow, Russia. Chinese President Xi Jinping is on a two-day visit to Russia. (Photo by Mikhail Svetlov/Getty Images)

“Western market capitalism” is generally defined as a system in which many economic agents interact and compete in decentralized competitive markets, with the state’s role confined to enforcing property rights, regulating markets, ensuring competition, and providing basic public goods financed by taxes. Obviously, this is an idealized version of what actually exists. But many political economists find it useful to contrast market capitalism with “state capitalism,” wherein the state directs investment decisions and owns/controls large segments of the economy, while still allowing for private ownership of the means of production.

Crony capitalism, by contrast, represents a category of its own. It is usually defined as a system in which private business actors and powerful political players forge close “insider connections” to secure large material benefits for themselves. Because the state always plays some role in the economy (either at the national or subnational level), there will always be some potential for cronyism, such as through the capture of public procurement spending, regulatory agencies, subsidies, and land zoning. And generally speaking, greater state involvement implies more opportunities for such abuses. Ultimately, though, neither market nor state capitalist systems are immune to crony capitalism.

Another factor that can increase the potential for cronyism is a lack of democratic control and accountability. In autocratic regimes, the rents from insider connections tend to be larger and “safer” than in countries with strong democratic institutions, including an independent judiciary and a free press. That said, the quality of democracy still matters. There are plenty of countries with free elections and even a relatively free press that nonetheless suffer rampant clientelism, corruption, and perverse campaign finance mechanisms.

All three books under review brandish the label “crony capitalism” in their titles, and each describes the relationship between private economic actors and political power in parts of the world where democracy is weak or absent, and where the state plays a large role in the economy. In Crony Capitalism in the Middle East, the eponymous system is defined as one in which “politically connected actors manage to extract economic advantage for their firms,” and where these rents are most often shared with the political actors that make them possible.

The editors, Ishac Diwan of Harvard University, Adeel Malik of the University of Oxford, and Izak Atiyas of Sabancı University, regard such connections as a universal feature of capitalism, particularly in its early stages. In their introduction, they present market and state capitalism not as two discrete systems, but rather as two points on a continuum. The state always plays a substantial role in the economy, they argue, and there have always been connections between the political and economic spheres, albeit with varying intensities and degrees of rent-sharing in different countries at different times.

Diwan, Malik, and Atiyas cite “the Rockefellers and the Carnegies whose private fortunes were built on exclusive insider deals with the public sector.” They also remind readers that the state capitalism of the “Asian Tigers” (Hong Kong, South Korea, Singapore, and Taiwan) featured many close ties between political and economic elites. The fact that these countries avoided the crony-capitalist label reflects the perception – largely correct – that insiders could reap large gains only through activities that were aligned with the state’s development goals, particularly when it came to export performance. There was also less rent sharing by political leaders than in other countries where strong connections with business leaders prevailed. One might conclude, then, that the pejorative ring of “crony capitalism” comes not so much from insider connections in themselves, but from the nature of the rentierism being practiced.

Crony Capitalism in the Middle East offers a rich and well-documented typology of private-public connections, and uses a combination of census and survey data and various measures of insider “connectedness” to explore their implications for economic performance. In terms of growth and job creation, the results in the periods being considered are not entirely clear-cut. The evidence points to a strong negative correlation between performance and connectedness in Egypt and Tunisia, but is not quite as conclusive in the cases of Lebanon and Morocco.

Meanwhile, Turkey’s manufacturing sector represents an exception. When the ruling Justice and Development Party (AKP) came to power in 2002, with the support of more religious parts of the country, it allowed many smaller firms close to its political base into sectors that large business groups (which were aligned with the older, secular political parties) had previously monopolized. In the 2000s, at least, this boosted productivity growth and broadened the Turkish economy’s formal sector. In the construction sector, by contrast, less competitive public procurement increased costs.

Apart from Turkish manufacturing, however, there is enough evidence to conclude that insider connections have imposed a significant burden on Middle Eastern economies, by creating barriers to entry, protecting quasi-monopolies, and channeling resources into rent seeking rather than toward efficient production and innovation. Perhaps, Diwan hopes, if change cannot come from “modern reformists” at the top, it might come from a bottom-up coalition, a glimpse of which we witnessed during the Arab Spring.

For their part, the Atlantic Council’s Anders Åslund and, to a lesser degree, the China scholar Minxin Pei see a starker contrast between market and state capitalism, which they argue is more likely to degenerate into outright crony capitalism.

In Russia’s Crony Capitalism, Åslund aims to explain how the country’s economic system has evolved under President Vladimir Putin. Åslund’s long and deep interest in Russia is obvious, and he uses an impressive array of facts, anecdotes, and sources to show that Putin has acquired near-unlimited personal power and has consciously shaped Russia’s political economy to ensure that his hold over the state cannot be seriously challenged. Åslund describes four “connected” circles surrounding Putin. The first three are the upper echelons of the security apparatus, the managers of state enterprises, and crony businessmen who are allowed to make huge profits, provided that they pledge absolute fealty to Putin and kick back a share of the wealth. Finally, there is an outer circle of tax havens and shell companies centered, interestingly, in the United Kingdom and the United States.

Åslund’s narrative distinguishes between three partly overlapping phases of Putin’s time in power. The first and “happiest” phase was in the early 2000s, when stability was restored after the chaos of the 1990s and the financial crisis of 1998. The second phase, starting in 2003, ushered in an inchoate system of state capitalism with the re-nationalization of productive assets. The third phase brought a full-bore expansion of cronyism, facilitated by the state’s increasing role in the economy – a role that has grown uninterrupted up to the present.

Most of Åslund’s book focuses on the 2000s, but refers back to the 1990s, including in its subtitle, “The Path from Market Economy to Kleptocracy.” Åslund’s description of this “path,” however, contains contradictions. For example, he praises the Boris Yeltsin era of rapid-fire market reforms following the collapse of communism, but concedes that “in 1991 a skilled operator could buy oil in Russia at an official price of one dollar per ton and sell it abroad at a price of one hundred dollars per ton.” That very fact should disqualify this period from excessive praise. As Branko Milanovic points out, while “the Putin oligarchs are billionaires who ‘serve’ at the discretion of the state … Yeltsin-type oligarchs … owned the state” (emphasis mine).

True, Åslund’s account is not incompatible with Milanovic’s. And yet, he seems to underestimate how the looting of public assets by a few elites in the 1990s created the political conditions – including broad public support – for the re-nationalization of the 2000s. Moreover, he doubles down in the book’s concluding chapter, advising future policymakers not to be too concerned about the “original sin” of looting in the 1990s.

Is this good advice? Though the Yeltsin-era oligarchs have decamped to Mayfair and the Upper East Side, and though their enterprises have been re-nationalized, the memory of the 1990s remains vivid. That is one reason why, as Åslund himself writes, “in 2016, 55 percent of the Russians regretted the collapse of the Soviet Union.” Given that this collective memory is unlikely to fade anytime soon, future reforms absolutely will have to account for its effects.

In China’s Crony Capitalism, Pei focuses on the post-Deng Xiaoping era, from 1998 to the present. “Instead of building socialism with Chinese characteristics,” he writes, “modernization under one-party rule has produced a form of rapacious crony capitalism.” Endemic to this system, he shows, are pervasive connections between public officials and businessmen, with the former facilitating the acquisition of large rent-based wealth by the latter, who then return the favor through kickbacks and similar emoluments.

Judging by Åslund and Pei’s descriptions, the contemporary Russian and Chinese varieties of crony capitalism have much in common. In fact, citing Pei, Åslund himself identifies many striking “qualitative similarities,” including a number of mechanisms that are essentially identical (and similar to those described in Crony Capitalism in the Middle East). Both books rely on a rich description of “facts,” some more reliably documented than others, rather than on formal statistical analysis. For example, Pei makes extensive use of evidence from corruption cases prosecuted in Chinese courts.

But there are also important differences between the portraits of China and Russia offered by these books. In China, collusion among elites has been more diffuse since the 1989 Tiananmen Square disaster, with provincial-level cronyism emerging as a dominant feature of the larger system. Given the sheer scale of the Chinese population and economy, it is not surprising that Chinese crony capitalism would be more decentralized than that of Russia. But another major factor has been the absence of clearly defined property rights, which has left vast opportunities for local officials to appropriate the yields of provincial assets, resulting in a certain loss of control by national leaders.

Moreover, unlike Russia, China does not rely almost entirely on the oil and gas sector for economic growth and revenue generation. And in gradually rolling out market and private sector-oriented reforms, Chinese leaders have not had to worry about collective memories of the chaos following sudden liberalization. So, while the features of crony capitalism described in both books may have come to resemble each other over time, their paths have been markedly different.

Åslund and Pei’s books also differ in their treatments of each country’s top leader. Åslund describes Putin as the architect and “owner” of the Russian system, and sees no possibility that the Putin regime will ever root out cronyism.

In contrast, Pei begins each chapter of his book with a different quote from Xi Jinping in which the Chinese president openly criticizes China’s crony capitalism. At first blush, these quotes may lead the reader to believe that Pei hopes Xi will address many of the negative features of China’s political economy. And Xi’s statements do suggest that he wants to create a true “developmental state,” implementing successful industrial policies of the type described by Reda Cherif and Fuad Hasanov in a recent IMF working paper (which itself cites the earlier success of the “Asian Tigers”).

Yet, while the Xi quotes seem to point in that direction, Pei goes on to argue that even if Xi wanted to develop such a system, he would fail. According to Pei, cronyism in China has simply become too prevalent and entrenched. Moreover, it has created wealth-based power centers beyond the reach of the state.

Is Pei correct? I, for one, think the jury is still out, given China’s successful track record of reform and continued economic performance. Following in the East Asian tradition, China, with its diversified export mix, seems to have a better chance than Russia does of creating a system in which the political leadership reliably requires strong economic performance from private business in exchange for facilitating large profits. Moreover, China’s dramatic GDP growth and poverty reduction over the past few decades was achieved under the kind of developmental state that Russia has never had.

To be sure, absent democratic institutions, political accountability in China will be lacking. But the Chinese leadership’s perceived legitimacy is more contingent on gains in overall economic prosperity than anything else. Xi’s consolidation of power may well lead to a breakdown of economic progress, owing to the negative effects of cronyism. But if he is willing, Xi could still succeed in building a developmental state that is fit for China’s entry into the digital age.

As MIT’s Daron Acemoglu and James A. Robinson of the University of Chicago have shown in their broader analysis of “why nations fail,” the outcome will depend on the kind of institution-building Xi undertakes. Yes, a personalized autocracy is not particularly conducive to the creation of strong, effective institutions. But for all of the cronyism and lack of democratic accountability in modern-day China, the system there simply does not fit Pei’s description of a “Leninist regime in late-stage decay.” The situation is more complicated than that.

The three books under review here show that the subject of crony capitalism is deeply embedded in ongoing debates about the role of markets and the state in development, income distribution and efficiency, and the relationship between democracy and economic performance. It is sobering to encounter strong disagreements on all of these issues, despite decades of analysis and empirical research. These disagreements partly reflect conflicting empirical evidence; but they are also the result of different value judgments.

Taken together, these three books will leave most readers amazed and despondent about the extent to which cronyism pervades the political economy of Russia, China, and many Middle Eastern countries. But, as we have seen, insider connections have sometimes operated in systems where a powerful state provides advantages to elites in exchange for broader macroeconomic outcomes. Systems where this kind of conditionality is dominant may not deserve the pejorative label of “crony capitalism,” despite their negative implications for equity. Indeed, “state capitalism” may be a better description in these cases. Only when the state fails to require exceptional economic performance from those it favors does the system devolve into crony capitalism.

The same distinction applies to market capitalism. Where regulations, taxes, and subsidies are designed to drive innovation, encourage optimal levels of competition, and ensure the diffusion of knowledge, market capitalism does not generate crony capitalism. But where regulatory capture is widespread, and democratic competition is largely financed by powerful special interests, market capitalism, too, can descend into cronyism. If there is one key difference to bear in mind, it is that democratic processes still stand out as the most effective tools for correcting the problem.

Finally, it is always worth remembering that economic objectives are not and should not be the only focus of development. At the nadir of the euro crisis, I can recall asking a Greek friend why, despite what he perceived as excessive austerity imposed by the European Union, he still wanted Greece to remain in the bloc. His answer was that he wanted to be sure that nobody could ever come in the middle of the night and deprive him of his freedom. Such concrete human concerns should always remain paramount when we attempt to classify systems of political economy and assign countries to abstract categories.

Kemal Derviş, former Minister of Economic Affairs of Turkey and former Administrator for the United Nations Development Program (UNDP), is Senior Fellow at the Brookings Institution.

Published Date: Friday, December 13th, 2019 | 07:48 PM

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